This one makes no sense to me. How is this a strategy to profit from falling prices in the ST. Schweser describes it as going long a high strike call and short a low strike call. Wouldn’t this then profit by prices going up? For ex. Current Price = 15 Strike = 20, premium = 2 long position Strike = 5, premium = 1 short position If the price is 10 at expiration, your long is out of the money so you earn the premium on the short minus the premium on the long = -1. You lose money. If the price is 25 at expiration you are in the money on the long so you earn 25-20=5 plus premium on short minus premium on long for a total profit of 4. So in other words you make money when the stock goes up and lose when it goes down. The bear put strategy makes perfect sense but I am at a loss on this one.
The idea is correct, but it seems like the premiums are wrong. If you look at buying both calls, you are paying $2 for the chance to buy the underlying at $20 in the future, or paying $1 to buy the underlying at $5 in the future. This is arbitrage galore… The lower call should have a higher premium, and at that large of a strike price difference, a much larger premium, say $10. That would make sense with the current price of the stock. You pay $10 to buy a stock at $5 in the future (total of $15) when the stock is currently trading in the open market at $15. They just have the wrong premium price. (priced more like puts, kinda)
A bear call spread you simply sell calls in equal amounts. Your max profit is the net. For instance. Call on XYZ 40 @ 5 Call on XYZ 35 @ 10 You make $5 if you sell the 35’s and buy the 40’s. Your worst case is break even in this situation (obviously not realistic). If prices go up, you can only lose the spread.
1morelevel: the bear call spread is actually as the OP explained, long higher strike, short lower strike, basically a short Bull spread. To have a non-covered short call is the most dangerous options positions to own, let alone two of them. Having one long and one short takes care of this issue.
I should proofread my replies.
If you write a call, and the market plummets it’s game on, right? That’s the principle. 1. You sell a call at a srike price just above market (that someone would actually buy); 2. You buy a call at a strike price just above that one you wrote (for a worst case scenario when the price goes to the moon); and 3. You pray that the price falls and both written and bought calls end up out of the money.
MT327 Wrote: ------------------------------------------------------- > This one makes no sense to me. How is this a > strategy to profit from falling prices in the ST. > Schweser describes it as going long a high strike > call and short a low strike call. Wouldn’t this > then profit by prices going up? > > For ex. > > Current Price = 15 > Strike = 20, premium = 2 long position > Strike = 5, premium = 1 short position > > If the price is 10 at expiration, your long is out > of the money so you earn the premium on the short > minus the premium on the long = -1. You lose > money. > If the price is $10 Long position’s payoff = 0 Short position’s payoff = -5 Net premium = 1-2 = -1 Net profit = -6 > If the price is 25 at expiration you are in the > money on the long so you earn 25-20=5 plus premium > on short minus premium on long for a total profit > of 4. > If the price is $25 Long position’s payoff = 5 Short position’s payoff = -20 Net payoff = -15 Net premium = 1-2 = -1 Net profit = -16 So you actually lost more when the price went up.